Final Thoughts on Upfront as Cable Stocks Get a Boost

Macro factors and "risk on, risk off" trading are back in control as upfront is completed. Cable stocks could get a boost from Verizon/T-Mobile spectrum.

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The conclusion of a slightly disappointing TV upfront selling season and renewed macroeconomic worries have brought the outlook for ad spending to the forefront for media stock investors. In addition, the stock market has reverted to the highly volatile "risk on, risk off" trading environment where stocks move in a highly correlated fashion as large investors place program trades simultaneously buying or selling entire indices and market sectors in both directions. This environment is frustrating for traditional investors like me, and for many observers, analysts, and employees of the media industries.

To recap, the upfronts for broadcast and cable were decent with total spending for broadcast flat and cable up low-to-mid single digits. These spending levels were slightly below expectations as recently as mid-May. My analysis of the shortfall is that a combination of General Motors' (GM) desire to cut spending, a weakening economic growth, a flare up of the crisis in Europe, and more discussion of the looming fiscal cliff and Presidential election created a poor demand environment for ad sellers.

Thus far, broadcast and cable network owners' stocks have not done unusually poorly against a volatile market. I would have expected worse. I think the prospect of Olympic and political spending keeping ad markets tight is helping. I also believe that investors see media stocks as somewhat cheaply valued given aggressive share repurchase programs, regularly increasing dividends, and below historical average price-to-earnings and price-to-cash flow ratios.

I continue to believe there is nothing unusual going in the national TV ad market. The market is acting normally now that the recovery off the cyclical has matured. Macro effects are magnified and ratings matter more to advertisers and investors. I still see CBS (CBS), News Corporation (NWSA), and Discovery Communications (DISCA) as winning investments relative to the group on the basis of above average ratings and growth outlooks.

Moving over to cable stocks, the stocks have acted quite well lately, with several pushing to new 52-week highs while the market was rallying in June. Given headlines of new government reviews of cable industry practices, the relative strength for the stocks is somewhat surprising. Investors appear to be appreciating the utility-like nature of monthly cable bills and the aggressive capital allocation programs that are returning rapidly growing free cash flow to shareholders.

This week began with what could be a new positive for cable stocks. Verizon (VZ) and T-Mobile announced a spectrum swap involving spectrum Verizon previously agreed to buy from the cable companies. The swap actually results in a net sale of spectrum to T-Mobile. At least one Wall Street analyst believes that T-Mobile will withdraw its objection to the deal between Verizon and the cable companies. T-Mobile had been leading opposition to the deal at the FCC.

Realizing cash value for unused spectrum it had been sitting on for more than five years is a nice boost to the cable industry capital allocation, shareholder friendliness investment theme. Not to be ignored is the fact that Verizon and the cable industry have moved ahead aggressively on the joint venture to market cable and wireless services together. Any improvement in cable industry net ads as a result – even less negative sub losses in TV – could be another position for cable stocks. I continue to be bullish on cable and prefer Comcast (CMCSA) and Charter Communications (CHTR).

Entermedia is a long/short equity hedge fund focused on media, communic=
ations, and related technologies. Steve Birenberg is co-portfolio manager o=
f Entermedia, owns a stake in the Funds' investment management compan=
y, and has personal monies invested in the Funds. CBS and Discovery Communi=
cations are widely held by Northlake Capital Management, LLC, including in =
Steve Birenberg's personal accounts. Steve is sole proprietor of Nort=
hlake, a long only registered investment advisor.

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